Stocks voodoo you should do

ThomasH. Kee Jr.

Thomas H. Kee Jr. is the president and CEO of
Stock Traders Daily (dotcom), where he offers strategies and newsletters to
both institutional and individual investors, and he manages money privately for
both institutional and individual investors through Equity Logic LLC. A
specialist in technical analysis, Kee is also the founder of one of the leading,
longer-term fundamental economic and stock market indicators in history, The
Investment Rate. This proprietary tool, which is available to clients, too,
predicts major economic cycles well in advance, and has been accurate since
1900. Using his broader observations of the economy to define disciplines, Kee
has been able to accurately predict market cycles in advance using his
multi-tiered technical indicators, and that combination has kept him ahead of
the curve since starting Stock Traders Daily in January 2000.

I recently wrote a column about reversal triggers and technical analysis and I was shocked to find out that so many people did not follow or did not understand technical analysis. In this article I attempt to explain the importance of technical analysis and how it can be used to increase your potential for realizing positive returns regardless if you use it as a means to actively trade or as a means to identify the best entry levels for your longer-term positions.

Normal investors who hear that a firm has put a strong buy rating on a stock might consider that a green light to go out and buy. Recently, Morgan Stanley announced a 5.9% stake in Open Table
OPEN
and investors thought that was a compelling reason to get involved, but the stock is already down 5% from where it was. Others might think that if Warren Buffett was buying a stock, he bought Bank of America
BAC, +0.19%
not so long ago, that it might be a good idea to follow along in his footsteps. Others might think that David Einhorn is bearish on green mountain coffee
GMCR, -0.53%
so short opportunities exist at current levels as well. In each instance we are hearing something from these institutional investors, but at no time does what we hear translate into an actionable event without additional diligence.

For example, although Buffett has made a large investment in Bank of America recently, he did not actually buy the stock, and anyone who bought on the heels of the announcement of his investment is already severely underwater. Eventually, that investment may indeed turn out to be a good one; the same might be true for recommendations that Morgan Stanley might make, or short recommendations that other institutional investors might suggest. However, rarely do institutional investors disclose their hands before they make a move. For example, one might argue that before David Einhorn disclosed that he was shorting green mountain coffee he had already taken his position. That means, in almost every circumstance, the institutional investor who normal investors are using as a gauge for timing probably has already gotten much better price points than the normal investor might be able to attain.

The reason normal investors react to published decisions of large institutional investors is that normal investors want to trade alongside smart money. There is absolutely nothing the matter with that, and I encourage every investor to follow this procedure. Everyone should always pay attention to what smart money is doing because smart money is smarter than all of us individually, but who is the “Smart Money?” Interestingly, that includes each and every institutional investor I have mentioned in this article and any and all other ones that you can think of. Smart money is not just one, but all investors combined.

More interestingly, every institutional investor has been wrong and I would bet that every institutional investor is going to be wrong again, but Smart Money is rarely wrong. Just look at what happened to John Paulson with Sino Forest
SNOFF
Paulsen is still a great manager; he has just gone through a period of utter turbulence. My point is even though these large institutional investors are intelligent, they are not by themselves smart money.

Instead, the definition of smart money transcends the individual investor and institutional managers and compounds the importance to include every investor, so by following Smart Money a person is not limiting himself to one Wall Street icon. All Investors, be them institutional or not, will be wrong from time to time, but smart money as I have defined it is almost always right. Put another way, if we follow what Smart Money is doing with their money we can increase the probabilities of being right ourselves.

If smart money is the composition of all investors on the market, and we want to identify the decisions they make with their pocketbooks, all we need to do is to identify the chart patterns of the market or the individual stock that we are considering and the result will tell us exactly what smart money has been doing and where they have been doing it, and that tells us where to do it ourselves. This tool is extremely powerful because it does not rely on one otherwise intelligent investor but instead on every investor, and that reduces the likelihood of error considerably. That is Technical Analysis.

With that reconciliation, understanding that technical analysis is not an analysis of random lines but instead an analysis of the decisions made by smart money, a higher degree of value might be given to this science. Technical analysis works to help you identify the proper entry levels for your investments, but like some will argue technical analysis does nothing to define the fundamentals of the stock or the market you're considering.

If you are attempting to invest in individual stocks you must conduct a fundamental analysis of the company too. Having the support of someone like Warren Buffett helps, and if you know that Warren Buffett is investing large amounts of money into a particular company (make sure he is buying equity and not debt) you can rest assured that he has done his homework and that company is probably sound. However, the proper entry level may not be today's market price; that will only be known after a technical analysis is conducted. For example, if the stock is at a level of resistance and poised to decline 10% or 15% back to support levels it would behoove anyone considering it to simply put that stock on radar, wait for it to test support levels, and enter the stock at that point instead. Otherwise, you might be faced with a situation where you are significantly underwater in a stock that is otherwise supported by a big-name institutional investor.

This same method of analysis can be used for active trading and for longer-term investing, the choice is yours, but technical analysis, being the science of following smart money, has a place in every portfolio. If you are not yet well versed in this science I encourage you to study it more, discover its value, and before you make any investment decision check the patterns and identify what smart money is doing. It could add significantly to your net return.

I conduct a detailed technical analysis of both near and long term patterns every day. These can be found on my website and are available for subscribers to review.

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